Does Performance-Based Managerial Compensation Affect Subsequent Corporate Performance?

47 Pages Posted: 18 Apr 2007 Last revised: 11 Aug 2010

See all articles by John M. Abowd

John M. Abowd

U.S. Census Bureau; Cornell University Department of Economics; Labor Dynamics Institute; School of Industrial and Labor Relations; NBER (on leave); CREST; IZA Institute of Labor Economics

Date Written: October 1989

Abstract

An effective performance-based compensation system must increase the probability of high performance corporate outcomes in order to justify the incremental expense relative to a straight salary system. A positive relation between current performance and current compensation indicates that the pay system is performance-based in practice, if not explicitly. This study considers whether increasing the sensitivity of current compensation to current performance is associated with higher performance in the future. For accounting-based performance measures, there is only weak evidence that greater performance-based compensation is associated with improved future performance. However, for economic and market performance measures, there is stronger evidence. Payment of an incremental 10% bonus for good economic performance is associated with a 30 to 90 basis point increase in the expected after tax gross economic return in the following fiscal year. Payment of an incremental raise of 10' following a good stock market performance is associated with a 400 to 1200 basis point increase in expected total shareholder return. These results are comparable in magnitude when compared to the intrinsic variability of the performance measure considered.

Suggested Citation

Abowd, John Maron, Does Performance-Based Managerial Compensation Affect Subsequent Corporate Performance? (October 1989). NBER Working Paper No. w3149, Available at SSRN: https://ssrn.com/abstract=980448

John Maron Abowd (Contact Author)

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